CONTENTS

CHAPTER 1....................................................................................................................................................6
DEBT INSTRUMENTS: FUNDAMENTAL FEATURES ................................................................6
1. 1
1. 2
1. 3
1. 4
1. 5

INSTRUMENT FEATURES ................................................................................................................. 6

MODIFYING THE COUPON OF A BOND ........................................................................................... 7
MODIFYING THE TERM TO MATURITY OF A BOND ...................................................................... 9
MODIFYING THE PRINCIPAL REPAYMENT OF A BOND .............................................................. 11
ASSET BACKED SECURITIES .......................................................................................................... 11

CHAPTER 2..................................................................................................................................................13
INDIAN DEBT MARKETS: A PROFILE...........................................................................................13
2. 1
2. 2
2. 3

MARKET SEGMENTS ...................................................................................................................... 13

PARTICIPANTS IN THE DEBT MARKETS........................................................................................ 15
SECONDARY MARKET FOR DEBT INSTRUMENTS ...................................................................... 17

CHAPTER 3..................................................................................................................................................24
CENTRAL GOVERNMENT S ECURITIES: BONDS .....................................................................24
3 . 1 INTRODUCTION............................................................................................................................... 24
3 . 2 G-SECS: TRENDS IN VOLUMES, TENOR AND YIELDS................................................................... 27
3 . 3 PRIMARY ISSUANCE PROCESS ...................................................................................................... 28
3 . 4 PARTICIPANTS IN GOVERNMENT BOND MARKETS ................................................................... 33
3 . 5 CONSTITUENT SGL ACCOUNTS..................................................................................................... 35
3 . 6 PRIMARY DEALERS ........................................................................................................................ 35
3.6.1 Eligibility....................................................................................................................................36
3.6.2 Bidding Commitment................................................................................................................36
3.6.3 Underwriting..............................................................................................................................36
3.6.4 Other Obligations......................................................................................................................38
3.6.5 Facilities for Primary Dealers................................................................................................39
3.6.6 Reporting System.......................................................................................................................40
3 . 7 SATELLITE DEALERS ...................................................................................................................... 40
3 . 8 SECONDARY MARKETS FOR GOVERNMENT BONDS................................................................. 41
3 . 9 SETTLEMENT OF TRADES IN G-SECS............................................................................................. 41
CHAPTER 4..................................................................................................................................................48
CENTRAL GOVERNMENT S ECURITIES: T-BILLS ...................................................................48
4. 1
4. 2
4. 3
4. 4

ISSUANCE PROCESS ........................................................................................................................ 48

CUT-OFF YIELDS.............................................................................................................................. 50
INVESTORS IN T-BILLS .................................................................................................................... 51
SECONDARY MARKET ACTIVITY IN T-BILLS ............................................................................... 51

CHAPTER 5..................................................................................................................................................53
STATE GOVERNMENT BONDS..........................................................................................................53
5. 1

GROSS FISCAL DEFICIT OF STATE GOVERNMENTS AND ITS FINANCING............................... 53

CHAPTER 1
DEBT INSTRUMENTS: FUNDAMENTAL
FEATURES
Debt instruments are contracts in which one party lends money to another on
pre-determined terms with regard to rate of interest to be paid by the
borrower to the lender, the periodicity of such interest payment, and the
repayment of the principal amount borrowed (either in installments or in
bullet). In the Indian securities markets, we generally use the term bond for
debt instruments issued by the Central and State governments and public
sector organisations, and the term debentures for instruments issued by
private corporate sector. 1

1.1 INSTRUMENT FEATURES

The principal features of a bond are:
a) Maturity
b) Coupon
c) Principal
In the bond markets, the terms maturity and term-to-maturity, are used
quite frequently. Maturity of a bond refers to the date on which the bond
matures, or the date on which the borrower has agreed to repay (redeem)
the principal amount to the lender. The borrowing is extinguished with
redemption, and the bond ceases to exist after that date. Term to maturity,
on the other hand, refers to the number of years remaining for the bond to
mature. Term to maturity of a bond changes everyday, from the date of issue
of the bond until its maturity.
Coupon Rate refers to the periodic interest payments that are made by the
borrower (who is also the issuer of the bond) to the lender (the subscriber of
the bond) and the coupons are stated upfront either directly specifying the
number (e.g.8%) or indirectly tying with a benchmark rate (e.g.
MIBOR+0.5%). Coupon rate is the rate at which interest is paid, and is
usually represented as a percentage of the par value of a bond.
Principal is the amount that has been borrowed, and is also called the par
value or face value of the bond. The coupon is the product of the principal
and the coupon rate. Typical face values in the bond market are Rs. 100
1

In this workbook the terms bonds, debentures and debt instruments have been used inter-changeably.

though there are bonds with face values of Rs. 1000 and Rs.100000 and
above. All Government bonds have the face value of Rs.100. In many cases,
the name of the bond itself conveys the key features of a bond. For example
a GS CG2008 11.40% bond refers to a Central Government bond maturing in
the year 2008, and paying a coupon of 11.40%. Since Central Government
bonds have a face value of Rs.100, and normally pay coupon semi-annually,
this bond will pay Rs. 5.70 as six- monthly coupon, until maturity, when the
bond will be redeemed.
The term to maturity of a bond can be calculated on any date, as the distance
between such a date and the date of maturity. It is also called the term or the
tenor of the bond. For instance, on February 17, 2004, the term to maturity
of the bond maturing on May 23, 2008 will be 4.27 years. The general day
count convention in bond market is 30/360European which assumes total 360
days in a year and 30 days in a month.
There is no rigid classification of bonds on the basis of their term to maturity.
Generally bonds with tenors of 1-5 years are called short-term bonds; bonds
with tenors ranging from 4 to 10 years are medium term bonds and above 10
years are long term bonds. In India, the Central Government has issued up to
30 year bonds.
Box 1.1: Computing term to maturity in years
The distance between a given date and the date on whic h a bond matures is
the term to maturity of a bond. This distance can be calculated in years, as
follows:
Use function YEARFRAC in Excel. The inputs are start_date which is the
date on which we want to measure the term to maturity of the bond;
end_date is the date on which the bond matures; basis is the manner in
which the number of days between the start and the end dates are to be
counted. The numbers 0-4 represent the various ways in which days can be
counted. We have used 4 which is a 30/360 days convention.
Another option is to use the function called DAYS360 and provide the start
and end date as well as the logical values. It would provide the days to
maturity. Divide the same by 360 would give the years.
The result is 4.27, which is the term to maturity of the bond, in years, on
February 17, 2004.

1.2 MODIFYING THE COUPON OF A BOND

In a plain vanilla bond, coupon is paid at a pre-determined rate, as a
percentage of the par value of the bond. Several modifications to the manner
in which coupons / interest on a bond are paid are possible.

Zero Coupon Bond

In such a bond, no coupons are paid. The bond is instead issued at a
discount to its face value, at which it will be redeemed. There are no
intermittent payments of interest. When such a bond is issued for a very long
tenor, the issue price is at a steep discount to the redemption value. Such a
zero coupon bond is also called a deep discount bond. The effective interest
earned by the buyer is the difference between the face value and the
discounted price at which the bond is bought. There are also instances of zero
coupon bonds being issued at par, and redeemed with interest at a premium.
The essential feature of this type of bonds is the absence of intermittent cash
flows.
Treasury Strips
In the United States, government dealer firms buy coupon paying treasury
bonds, and create out of each cash flow of such a bond, a separate zero
coupon bond. For example, a 7-year coupon-paying bond comprises of 14
cash flows, representing half-yearly coupons and the repayment of principal
on maturity. Dealer firms split this bond into 14 zero coupon bonds, each one
with a differing maturity and sell them separately, to buyers with varying
tenor preferences. Such bonds are known as treasury strips. (Strips is an
acronym for Separate Trading of Registered Interest and Principal Securities).
We do not have treasury strips yet in the Indian markets. RBI and
Government are making efforts to develop market for strips in government
securities.
Floating Rate Bonds
Instead of a pre-determined rate at which coupons are paid, it is possible to
structure bonds, where the rate of interest is re-set periodically, based on a
benchmark rate. Such bonds whose coupon rate is not fixed, but reset with
reference to a benchmark rate, are called floating rate bonds. For example,
IDBI issued a 5 year floating rate bond, in July 1997, with the rates being reset semi-annually with reference to the 10 year yield on Central Government
securities and a 50 basis point mark-up. In this bond, every six months, the
10-year benchmark rate on government securities is ascertained. The coupon
rate IDBI would pay for the next six months is this benchmark rate, plus 50
basis points. The coupon on a floating rate bond thus varies along with the
benchmark rate, and is reset periodically.
The Central Government has also started issuing floating rate bonds tying the
coupon to the average cut-off yields of last six 364-day T-bills yields.
Some floating rate bonds also have caps and floors, which represent the
upper and lower limits within which the floating rates can vary. For example,
the IDBI bond described above had a floor of 13.5%. This means, the lender
would receive a minimum of 13.5% as coupon rate, should the benchmark
rate fall below this threshold. A ceiling or a cap represents the maximum

interest that the borrower will pay, should the benchmark rate move above
such a level. Most corporate bonds linked to the call rates, have such a
ceiling to cap the interest obligation of the borrower, in the event of the
benchmark call rates rising very steeply. Floating rate bonds, whose coupon
rates are bound by both a cap and floor, are called as range notes, because
the coupon rates vary within a certain range.
The other names, by which floating rate bonds are known, are variable rate
bonds and adjustable rate bonds. These terms are generally used in the case
of bonds whose coupon rates are reset at longer time intervals of a year and
above. These bonds are common in the housing loan markets.
In the developed markets, there are floating rate bonds, whose coupon rates
move in the direction opposite to the direction of the benchmark rates. Such
bonds are called inverse floaters.
Other Variations
In the mid-eighties, the US markets witnessed a variety of coupon structures
in the high yield bond market (junk bonds) for leveraged buy-outs. In many
of these cases, structures that enabled the borrowers to defer the payment of
coupons were created.
Some of the more popular structures were: (a)
deferred interest bonds, where the borrower could defer the payment of
coupons in the initial 3 to 7 year period; (b) Step-up bonds, where the
coupon was stepped up by a few basis points periodically, so that the interest
burden in the initial years is lower, and increases over time; and (c)
extendible reset bond, in which investment bankers reset the rates, not on
the basis of a benchmark, but after re-negotiating a new rate, which in the
opinion of the lender and borrower, represented the rate for the bond after
taking into account the new circumstances at the time of reset.

1.3 MODIFYING THE TERM TO MATURITY OF A BOND

Callable Bonds
Bonds that allow the issuer to alter the tenor of a bond, by redeeming it prior
to the original maturity date, are called callable bonds. The inclusion of this
feature in the bonds structure provides the issuer the right to fully or partially
retire the bond, and is therefore in the nature of call option on the bond.
Since these options are not separated from the original bond issue, they are
also called embedded options. A call option can be an European option,
where the issuer specifies the date on which the option could be exercised.
Alternatively, the issuer can embed an American option in the bond, providing
him the right to call the bond on or anytime before a pre-specified date.
The call option provides the issuer the option to redeem a bond, if interest
rates decline, and re-issue the bonds at a lower rate. The investor, however,

loses the opportunity to stay invested in a high coupon bond, when interest
rates have dropped. The call option, therefore, can effectively alter the term
of a bond, and carries an added set of risks to the investor, in the form of call
risk, and re-investment risk. As we shall see later, the prices at which these
bonds would trade in the market are also different, and depend on the
probability of the call option being exercised by the issuer. In the home loan
markets, pre-payment of housing loans represent a special case of call
options exercised by borrowers. Housing finance companies are exposed to
the risk of borrowers exercising the option to pre-pay, thus retiring a housing
loan, when interest rates fall. The Central Government has also issued an
embedded option bond that gives options to both issuer (Government) and
the holders of the bonds to exercise the option of call/put after expiry of 5
years. This embedded option would reduce the cost for the issuer in a falling
interest rate scenario and helpful for the bond holders in a rising interest rate
scenario.
Puttable Bonds
Bonds that provide the investor with the right to seek redemption from the
issuer, prior to the maturity date, are called puttable bonds. The put options
embedded in the bond provides the investor the rights to partially or fully sell
the bonds back to the issuer, either on or before pre-specified dates. The
actual terms of the put option are stipulated in the original bond indenture.
A put option provides the investor the right to sell a low coupon-paying bond
to the issuer, and invest in higher coupon paying bonds, if interest rates move
up.
The issuer will have to re-issue the put bonds at higher coupons.
Puttable bonds represent a re-pricing risk to the issuer. When interest rates
increase, the value of bonds would decline. Therefore put options, which seek
redemptions at par, represent an additional loss to the issuer.
Convertible Bonds
A convertible bond provides the investor the option to convert the value of
the outstanding bond into equity of the borrowing firm, on pre-specified
terms.
Exercising this option leads to redemption of the bond prior to
maturity, and its replacement with equity. At the time of the bonds issue,
the indenture clearly specifies the conversion ratio and the conversion price.
The conversion ratio refers to the number of equity shares, which will be
issued in exchange for the bond that is being converted. The conversion price
is the resulting price when the conversion ratio is applied to the value of the
bond, at the time of conversion.
Bonds can be fully converted, such that
they are fully redeemed on the date of conversion. Bonds can also be issued
as partially convertible, when a part of the bond is redeemed and equity
shares are issued in the pre-specified conversion ratio, and the nonconvertible portion continues to remain as a bond.

10

1.4 MODIFYING THE PRINCIPAL REPAYMENT OF A

BOND
Amortising Bonds
The structure of some bonds may be such that the principal is not repaid at
the end/maturity, but over the life of the bond. A bond, in which payment
made by the borrower over the life of the bond, includes both interest and
principal, is called an amortising bond. Auto loans, consumer loans and home
loans are examples of amortising bonds. The maturity of the amortising bond
refers only to the last payment in the amortising schedule, because the
principal is repaid over time.
Bonds with Sinking Fund Provisions
In certain bond indentures, there is a provision that calls upon the issuer to
retire some amount of the outstanding bonds every year. This is done either
by buying some of the outstanding bonds in the market, or as is more
common, by creating a separate fund, which calls the bonds on behalf of the
issuer. Such provisions that enable retiring bonds over their lives are called
sinking fund provisions. In many cases, the sinking fund is managed by
trustees, who regularly retire part of the outstanding bonds, usually at par.
Sinking funds also enable paying off bonds over their life, rather than at
maturity. One usual variant is applicability of the sinking fund provision after
few years of the issue of the bond, so that the funds are available to the
borrower for a minimum period, before redemption can commence.

1.5 ASSET BACKED SECURITIES

Asset backed securities represent a class of fixed income securities, created
out of pooling together assets, and creating securities that represent
participation in the cash flows from the asset pool. For example, select
housing loans of a loan originator (say, a housing finance company) can be
pooled, and securities can be created, which represent a claim on the
repayments made by home loan borrowers.
Such securities are called
mortgagebacked securities.
In the Indian context, these securities are
known as structured obligations (SO). Since the securities are created from a
select pool of assets of the originator, it is possible to cherry-pick and create
a pool whose asset quality is better than that of the originator. It is also
common for structuring these instruments, with clear credit enhancements,
achieved either through guarantees, or through the creation of exclusive preemptive access to cash flows through escrow accounts. Assets with regular
streams of cash flows are ideally suited for creating asset-backed securities.
In the Indian context, car loan and truck loan receivables have been
securitized. Securitized home loans represent a very large segment of the US
bond markets, next in size only to treasury borrowings. However, the market

11

for securitization has not developed appreciably because of the lack of legal
clarity and conducive regulatory environment.
The Securitization and Reconstruction of Financial Assets and Enforcement of
Security Interest Act were approved by parliament in November 2002. The
Act also provides a legal framework for securitization of financial assets and
asset reconstruction.
The securitization companies or reconstruction
companies shall be regulated by RBI. The security receipts issued by these
companies will be securities within the meaning of the Securities Contract
(Regulation) Act, 1956. These companies would have powers to acquire
assets by issuing a debenture or bond or any other security in the nature of
debenture in lieu thereof. Once an asset has been acquired by the asset
reconstruction company, such company would have the same powers for
enforcement of securities as the original lender. This has given the legal
sanction to securitized debt in India.
Model Questions
1. On value date June 10, 2000, what is the term to maturity in
years, of a government security maturing on 23 rd March 2004?
Use the yearfrac function in Excel, with the following specifications:
Settlement date: June 10, 2000
Maturity Date: March 23, 2004
Basis: 4. (Government securities trade on 30/360 European basis. We
therefore use 4, in the Excel function, which applies this day count
convention).
Ans: 3.786 years.
2. Which of the following about a callable bond is true?
a.
b.
c.
d.
Ans:

Callable bonds always trade at a discount to non-callable bonds.

Callable bonds expose issuers to the risk of reduced re-investment
return.
Callable bonds are actually variable tenor bonds.
Callable bonds are not as liquid as non-callable bonds.
c.

3. Coupon of a floating rate bond is _______

a. modified whenever there is a change in the benchmark rate.
b. modified at pre-set intervals with reference to a benchmark rate.
c. modified for changes in benchmark rate beyond agreed levels.
d. modified within a range, for changes in the benchmark rate.
Ans:

b.

12

CHAPTER 2
INDIAN DEBT MARKETS: A PROFILE
Indian debt markets, in the early nineties, were characterised by controls on
pricing of assets, segmentation of markets and barriers to entry, low levels of
liquidity, limited number of players, near lack of transparency, and high
transactions cost. Financial reforms have significantly changed the Indian
debt markets for the better. Most debt instruments are now priced freely on
the markets; trading mechanisms have been altered to provide for higher
levels of transparency, higher liquidity, and lower transactions costs; new
participants have entered the markets, broad basing the types of players in
the markets; methods of security issuance, and innovation in the structure of
instruments have taken place; and there has been a significant improvement
in the dissemination of market information.

2.1 MARKET SEGMENTS

There are three main segments in the debt markets in India, viz.,
Government Securities, Public Sector Units (PSU) bonds, and corporate
securities. The market for Government Securities comprises the Centre, State
and State-sponsored securities. In the recent past, local bodies such as
municipalities have also begun to tap the debt markets for funds. The PSU
bonds are generally treated as surrogates of sovereign paper, sometimes due
to explicit guarantee and often due to the comfort of public ownership. Some
of the PSU bonds are tax free, while most bonds including government
securities are not tax-free. The RBI also issues tax-free bonds, called the
6.5% RBI relief bonds, which is a popular category of tax-free bonds in the
market. Corporate bond markets comprise of commercial paper and bonds.
These bonds typically are structured to suit the requirements of investors and
the issuing corporate, and include a variety of tailor- made features with
respect to interest payments and redemption. The less dominant fourth
segment comprises of short term paper issued by banks, mostly in the form
of certificates of deposit.
The market for government securities is the oldest and most dominant in
terms of market capitalisation, outstanding securities, trading volume and
number of participants. It not only provides resources to the government for
meeting its short term and long term needs, but also sets benchmark for
pricing corporate paper of varying maturities and is used by RBI as an
instrument of monetary policy. The instruments in this segment are fixed
coupon bonds, commonly referred to as dated securities, treasury bills,
floating rate bonds, zero coupon bonds and inflation index bonds. Both

13

Central and State government securities comprise this segment of the debt
market.
The issues by government sponsored institutions like, Development Financial
Institutions, as well as the infrastructure-related bodies and the PSUs, who
make regular forays into the market to raise medium-term funds, constitute
the second segment of debt markets. The gradual withdrawal of budgetary
support to PSUs by the government since 1991 has compelled them to look at
the bond market for mobilising resources. The preferred mode of issue has
been private placement, barring an occasional public issue. Banks, financial
institutions and other corporates have been the major subscribers to these
issues. The tax-free bonds, which constitute over 50% of the outstanding PSU
bonds, are quite popular with institutional players.
The market for corporate debt securities has been in vogue since early 1980s.
Until 1992, interest rate on corporate bond issuance was regulated and was
uniform across credit categories. In the initial years, corporate bonds were
issued with sweeteners in the form of convertibility clause or equity
warrants. Most corporate bonds were plain coupon paying bonds, though a
few variations in the form of zero coupon securities, deep discount bonds and
secured promissory notes were issued.
After the de-regulation of interest rates on corporate bonds in 1992, we have
seen a variety of structures and instruments in the corporate bond markets,
including securitized products, corporate bond strips, and a variety of floating
rate instruments with floors and caps. In the recent years, there has been an
increase in issuance of corporate bonds with embedded put and call options.
The major part of the corporate debt is privately placed with tenors of 1-12
years.
Information on the size of the various segments of the debt market in India is
not readily available. This is due to the fact that many debt instruments are
privately placed and therefore not listed on markets. While the RBI regulates
the issuance of government securities, corporate debt securities fall under the
regulatory purview of SEBI. The periodic reports of issuers and investors are
therefore sent to two different regulators. Therefore, aggregated data for the
market as a whole is difficult to obtain. The NSE provides a trading platform
for most debt instruments issued in India. Therefore, Table 2.1 on market
capitalization can be said to be indicative of the relative size of the various
segments of the debt market.
The debt markets also have a large segment which is a non-securitized,
transactions based segment, where players are able to lend and borrow
amongst themselves. These are typically short term segments and comprise
of call and notice money markets, which is the most active segment in the
debt markets, inter-bank market for term money, markets for inter-corporate
loans and markets for ready forward deals (repos).

14

Table 2.1: Market Capitalisation - NSE-WDM Segment as on March 31,

2008.
Security Type
Market
Share in
Capitalisation
Total(%)
(Rs.cr.)
Government Securities
1,392,219
65.57
PSU Bonds
96268.47
4.53
State Loans
315660.71
14.87
Treasury Bills
111562.13
5.25
Financial Institutions
32092.92
1.51
Corporate Bonds
75675.73
3.56
Others
99867.09
4.70
TOTAL
2123346.28
100.00
* Others include securitized debt and bonds of local bodies.

2.2 PARTICIPANTS IN THE DEBT MARKETS

Debt markets are pre-dominantly wholesale markets, with dominant
institutional investor participation.
The investors in the debt markets
concentrate in banks, financial institutions, mutual funds, provident funds,
insurance companies and corporates. Many of these participants are also
issuers of debt instruments. The smaller number of large players has resulted
in the debt markets being fairly concentrated, and evolving into a wholesale
negotiated dealings market.
Most debt issues are privately placed or
auctioned to the participants. Secondary market dealings are mostly done on
telephone, through negotiations. In some segments such as the government
securities market, market makers in the form of primary dealers have
emerged, who enable a broader holding of treasury securities. Debt funds of
the mutual fund industry, comprising of liquid funds, bond funds and gilt
funds, represent a recent mode of intermediation of retail investments into
the debt markets, apart from banks, insurance, provident funds and financial
institutions, who have traditionally been major intermediaries of retail funds
into debt market products.
The market participants in the debt market are:
1. Central Governments, raising money through bond issuances, to fund
budgetary deficits and other short and long term funding requirements.
2. Reserve Bank of India, as investment banker to the government, raises
funds for the government through bond and t-bill issues, and also
participates in the market through open- market operations, in the course
of conduct of monetary policy. The RBI regulates the bank rates and repo
rates and uses these rates as tools of its monetary policy. Changes in
these benchmark rates directly impact debt markets and all participants in
the market.

15

3. Primary dealers, who are market intermediaries appointed by the Reserve

Bank of India who underwrite and make market in government securities,
and have access to the call markets and repo markets for funds.
4. State Governments, municipalities and local bodies, which issue securities
in the debt markets to fund their developmental projects, as well as to
finance their budgetary deficits.
5. Public sector units are large issuers of debt securities, for raising funds to
meet the long term and working capital needs. These corporations are
also investors in bonds issued in the debt markets.
6. Corporate treasuries issue short and long term paper to meet the financial
requirements of the corporate sector. They are also investors in debt
securities issued in the market.
7. Public sector financial institutions regularly access debt markets with
bonds for funding their financing requirements and working capital needs.
They also invest in bonds issued by other entities in the debt markets.
8. Banks are the largest investors in the debt markets, particularly the
treasury bond and bill markets. They have a statutory requirement to
hold a certain percentage of their deposits (currently the mandatory
requirement is 25% of deposits) in approved securities (all government
bonds qualify) to satisfy the statutory liquidity requirements. Banks are
very large participants in the call money and overnight markets. They are
arrangers of commercial paper issues of corporates. They are also active
in the inter-bank term markets and repo markets for their short term
funding requirements.
Banks also issue CDs and bonds in the debt
markets.
9. Mutual funds have emerged as another important player in the debt
markets, owing primarily to the growing number of bond funds that have
mobilised significant amounts from the investors. Most mutual funds also
have specialised bond funds such as gilt funds and liquid funds. Mutual
funds are not permitted to borrow funds, except for very short-term
liquidity requirements. Therefore, they participate in the debt markets
pre-dominantly as investors, and trade on their portfolios quite regularly.
10. Foreign Institutional Investors are permitted to invest in Dated
Government Securities and Treasury Bills within certain specified limits.
11. Provident funds are large investors in the bond markets, as the prudential
regulations governing the deployment of the funds they mobilise, mandate
investments pre-dominantly in treasury and PSU bonds.
They are,
however, not very active traders in their portfolio, as they are not
permitted to sell their holdings, unless they have a funding requirement
that cannot be met through regular accruals and contributions.
12. Charitable Institutions, Trusts and Societies are also large investors in the
debt markets. They are, however, governed by their rules and byelaws
with respect to the kind of bonds they can buy and the manner in which
they can trade on their debt portfolios.
The matrix of issuers, investors, instruments in the debt market and their
maturities are presented in Table 2.2.

16

Table 2.2: Participants and Products in Debt Markets

Issuer
Instrument
Maturity
Investors
Central
Dated
2-30years
RBI,
Banks,
Insurance
Government
Securities
Companies,
Provident
Funds,
Mutual
Funds,
PDs, Individuals
Central
T-Bills
91/182/364 RBI,
Banks,
Insurance
Government
days
Companies,
Provident
Funds,
PDs,
Mutual
Funds, Individuals
State
Dated
5-13 years
Banks,
Insurance
Government
Securities
Companies,
Provident
Funds, RBI, Mutual Funds,
Individuals, PDs.
PSUs
Bonds,
5-10 years
Banks,
Insurance
Structured
Companies,
Corporate,
Obligations
Provident Funds, Mutual
Funds, Individuals
Corporates
Debentures
1-12 years
Banks,
Mutual
Funds,
Corporates, Individuals
Corporates,
PDs

Scheduled
Commercial
Banks
Financial
Institutions
Scheduled
Commercial
Banks
Municipal
Corporation

Commercial
paper

Certificates
of Deposit
(CDs)
Bank Bonds

Municipal
Bonds

7 days to 1
year

7 days to 1
year
1 year to 3
years
1-10 years

0-7 years

Banks,
Corporate,
Financial
institutions,
Mutual Funds, Individuals,
FIIs
Banks,
Corporations,
Individuals,
Companies,
Trusts,
Funds,
Associations, FIs, NRIs
Corporations,
Individual
Companies,
Trusts,
Funds, Associations, FIs,
NRIs
Banks,
Corporations,
Individuals,
Companies,
Trusts,
Funds,
Associations, FIs, NRIs

2.3 SECONDARY MARKET FOR DEBT INSTRUMENTS

The NSE- WDM segment provides the formal trading platform for trading of a
wide range of debt securities. Initially, government securities, treasury bills
and bonds issued by public sector undertakings (PSUs) were made available
for trading. This range has been widened to include non-traditional
instruments like, floating rate bonds, zero coupon bonds, index bonds,

17

commercial papers, certificates of deposit, corporate debentures, state

government loans, SLR and non-SLR bonds issued by financial institutions,
units of mutual funds and securitized debt. The WDM trading system, known
as NEAT (National Exchange for Automated Trading), is a fully automated
screen based trading system that enables members across the country to
trade simultaneously with enormous ease and efficiency. The trading system
is an order driven system, which matches best buy and sell orders on a
price/time priority.
Central Government securities and treasury bills are held as dematerialised
entries in the Subsidiary General Ledger (SGL) of the RBI. In order to trade
these securities, participants are required to have an account with the SGL
and also a current account with the RBI. The settlement is on Delivery versus
Payment (DvP) basis. The Public Debt Office which oversees the settlement of
transactions through the SGL enables the transfer of securities from one
participant to another.
Since 1995, settlements are on delivery-versuspayment basis. However, after creation of Clearing Corporation of India,
most of the institutional trades are being settled through CCIL with settlement
guarantee. The settlement through CCIL is taking place on DvP-III where
funds and securities are netted for settlement.
Government debt, which constitutes about three-fourth of the total
outstanding debt, has the highest level of liquidity amongst the fixed income
instruments in the secondary market. The share of dated securities in total
turnover of government securities has been increasing over the years. Twoway quotes are available for active gilt securities from the primary dealers.
Though many trades in gilts take place through telephone, a larger chunk of
trades gets routed through NSE brokers.
The instrument-wise turnover for securities listed on the NSE-WDM is shown
in Table 2.3. It is observed that the market is dominated by dated
government securities (including state development loan).
Table 2.3: Security-wise Distribution of Turnover on NSE WDM

Securities
Government Securities
Treasury Bills
PSU/Institutional Bonds
Others

Percentage Share of Turnover

2005-06
2006-07
2007-08
72.67
70
68.84
22.13
23.71
23.40
2.56
2.02
3.27
2.64
4.27
4.49

The major participants in the WDM are the Indian banks, foreign banks and
primary dealers, who together accounted for over 59.51% of turnover during
2007-08. The share of Indian banks in turnover is about 23.78% in 2007-08
while foreign banks constitute about 27.09% and primary dealers account for

18

8.64%. Financial institutions and mutual funds contribute about 2.34% of the
turnover. The participant-wise distribution of turnover is presented in Table
2.4.
Table 2.4: Participant- wise Distribution of Turnover (%)

Participant
Foreign Banks
Indian Banks
Primary Dealers
FIs, MF and Corporates
Trading Members
TOTAL

200506

200607

200708

14.11
28.07

20.57
26.03

27.09
23.78

21.89
3.92
3.92

19.82
2.7
30.88

8.64
2.34
38.15

100.00

100.00

100.00

As seen in Table 2.5, the share of top 10 securities in turnover is 39.65% in

2007-08 and top 50 securities accounted for nearly 79.64% of turnover in
the same period.
Table 2.5:
Segment
Year

1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08

Share of Top 'N' Securities in the Turnover of WDM

Percentage Share of Turnover

Top
Top
Top
Top
5
10
25
50
42.84
61.05
80.46
89.81
57.59
69.46
79.60
86.58
32.93
48.02
65.65
78.32
30.65
46.92
71.25
85.00
26.81
41.89
64.30
78.24
37.11
55.57
82.12
90.73
42.20
58.30
80.73
89.97
51.61
68.50
88.73
94.32
43.10
65.15
86.91
92.74
37.06
54.43
81.58
90.66
43.70
57.51
71.72
80.59
47.42
59.78
72.02
81.04
40.90
51.29
65.82
77.15
39.65
53.31
68.35
79.64

Top
100
97.16
93.24
90.17
92.15
86.66
95.28
95.13
97.19
96.13
95.14
89.55
89.36
86.91
89.55

Retail Debt Market

With a view to encouraging wider participation of all classes of investors
across the country (including retail investors) n
i government securities, the
Government, RBI and SEBI have introduced trading in government securities

19

for retail investors. Trading in this retail debt market segment (RDM) on NSE
has been introduced w.e.f. January 16, 2003.
RDM Trading:
Trading takes place in the existing Capital Market segment of the Exchange
and in the same manner in which the trading takes place in the equities
(Capital Market) segment. The RETDEBT Market facility on the NEAT system
of Capital Market Segment is used for entering transactions in RDM session.
The trading holidays and market timings of the RDM segment are the same as
the Equities segment.
Trading Parameters:
The trading parameters for RDM segment are as below:
Face Value

Rs. 100/-

Permitted Lot Size

10

Tick Size

Rs. 0.01

Operating Range

+/- 5%

Mkt. Type Indicator

D (RETDEBT)

Book Type

RD

Trading in Retail Debt Market is permitted under Rolling Settlement, where in

each trading day is considered as a trading period and trades executed during
the day are settled based on the net obligations for the day. Settlement is on
a T+2 basis. National Securities Clearing Corporation Limited (NSCCL) is the
clearing and settlement agency for all deals executed in Retail Debt Market.
Negotiated Dealing System
The first step towards electronic bond trading in India was the introduction of
the RBIs Negotiated Dealing System in February 2002.
NDS, interalia, facilitates screen based negotiated dealing for secondary
market transactions in government securities and money market instruments,
online reporting of transactions in the instruments available on the NDS and
dissemination of trade information to the market. Government Securities
(including T-bills), call money, notice/term money, repos in eligible securities
are available for negotiated dealing through NDS among the members. NDS
members concluding deals, in the telephone market in instruments available
on NDS, are required to report the deal on NDS system within 15 minutes of
concluding the deal. NDS interfaces with CCIL for settlement of government
securities transactions for both outright and repo trades done/reported by
NDS members. Other instruments viz, call money, notice/term money,
commercial paper and certificate of deposits settle as per existing settlement
procedure.

20

With the objective of creating a broad-based and transparent market in

government securities and thereby enhancing liquidity in the system, the NDS
was designed to provide:

Electronic bidding in primary market auctions (T-Bills, dated securities,

state government securities) by members,
Electronic bidding for OMO of RBI including repo auctions under LAF,
Screen based negotiated dealing system for secondary market
operations,
Reporting of deals in government securities done among NDS
members outside the system (over telephone or using brokers of
exchanges) for settlement,
Dissemination of trade information to NDS members,
Countrywide access of NDS through INFINET,
Electronic connectivity for settlement of trades in secondary market
both for outright and repos either through CCIL or directly through
RBI, and Creation and maintenance of basic data of instruments and
members.

The functional scope of the NDS relating to trading includes:

giving/receiving a Quote,
placing a call and negotiation (with or without a reference to the quote),
entering the deals successfully negotiated,
setting up preferred counterparty list and exposure limits to the
counterparties,
dissemination of on-line market information such as the last traded prices
of securities, volume of transactions, yield curve and information on live
quotes,
interface with Securities Settlement System for facilitating settlement of
deals done in government securities and treasury bills.
facility for reporting on trades executed through the exchanges for
information dissemination and settlement in addition to deals done
through NDS.

The system is designed to maintain anonymity of buyers and sellers from the
market but only the vital information of a transaction viz., ISIN of the
security, nome nclature, amount (face value), price/rate and/ or indicative
yield, in case applicable, are disseminated to the market, through Market and
Trade Watch.
The benefits of NDS include:

Transparency of trades in money and government securities market,

Electronic connectivity with securities settlement systems, thus,
eliminating submission of physical SGL form,

21

Settlement through electronic SGL transfer,

Elimination of errors and discrepancies and delay inherent in manual
processing system, and
Electronic audit trail for better monitoring and control.

NDS-OM
NDS was intended to be used principally for bidding in the primary auctions
o f G-secs conducted by RBI, and for trading and reporting of secondary
market transactions. However, because of several technic al problems and
system inefficiencies, NDS was being used as a reporting platform for
secondary market transactions and not as a dealing system. For actual
transactions, its role was limited to placing bids in primary market auctions.
Much of secondary market in the bond market continued to be broker
intermediated.
It was therefore, decided to introduce a screen-based (i.e electronic)
anonymous order matching system, integrated with NDS. This system (NDSOM) has become operational with effect from August 1, 2005.
NDS-OM is an electronic, screen based, anonymous order driven trading
system introduced by RBI as part of the existing NDS system to facilitate
electronic dealing in government securities. It is accessible to members
through RBIs INFINET Network. The system facilitates price discovery,
liquidity, increased operational efficiency and transparency. The NDS-OM
System supports trading in all Central Government Dated Securities and State
Government securities in T+1 settlement type. Since August 1, 2006 the
system was enhanced to facilitate trading in Treasury Bills and When Issued
transaction in a security authorized for issuance but not as yet actually
issued. All WI transactions are on an if basis, to be settled if and when the
actual security is issued. Further, RBI has permitted the execution of intraday short sale transaction and the covering of the short position in
government securities can be done both on and outside the NDS-OM platform
i.e. through telephone market.
The order system is purely order driven with all bids/offers being matched
based on price/time priority for securities traded on price terms and
yield/time priority for securities traded on yield, ensuring transparency and
fairness to all users. This ensures a level playing field for all participants. The
trader gets the best bid/offer in the system. It then tries to match the sale
orders with the purchase orders available on the system. When a match
occurs, the trade is confirmed. The counterparties are not aware of each
others identities- hence the anonymous nature of the system.
While initially only banks and primary dealers could trade on it, NDS-OM has
been gradually expanded to cover other institutional players like insurance

22

companies, mutual funds, etc. Further, NDS-OM has been extended to cover
all entities required by law or regulation to invest in Government securities
such as deposit taking NBFCs, Provident Funds, Pension Funds, Mutual Funds,
Insurance Companies, Cooperative Banks, Regional Rural Banks, Trusts, etc.
The NDS-OM has several advantages over the erstwhile telephone based
market. It is faster, transparent, cheaper and provides benefits to its users
like straight through processing, audits trails for transactions. Straight
through processing (STP) of transactions means that, for participants using
CCILs clearing and settlement system, once a deal has been struck on NDSOM, no further human intervention is necessary right upto settlement, thus
eliminating possibilities human errors. The trades agreed on this system flow
directly to CCIL for settlement.
Model Questions
1.
Which of the following about the market capitalisation of
corporate bonds in the NSE WDM is true?
a. Corporate bonds account for over 10% of the total market capitalisation.
b. Corporate bonds represent the second largest segment of bonds, after
Government securities.
c. Market capitalisation of corporate bonds is lower than that of listed state
loans.
d. None of the above.
Ans: c
2.
a.
b.
c.
d.

The most active participants in the WDM segment of the NSE are:
Primary dealers
Scheduled banks
Trading members
Mutual Funds

Ans: b
3.Which of the following statements are true about NDS-OM ?
a. NDS-OM is a screen-based anonymous order matching system
b. NDS-OM became operational with effect from August 1, 2005
c. NDS-OM is faster, transparent and cheaper and provides benefits like
audit trail.
d. All of the above
Ans: d

23